Economic Logic, Too

About Me

I discuss recent research in Economics and various events from an economic perspective, as the name of the blog indicates. I plan on adding posts approximately every workday, with some exceptions, for example when I travel.

Tuesday, September 1, 2009

There is a surprising amount of research on business cycles, and also public concern about recessions, if your consider the most influential work on the topic. In his 1987 book, Robert Lucas claimed that the welfare cost of business cycle was minimal. The model he used was utterly simple, in particular with a represntative household and has been attacked many times since. But in his 2003 AEA presidential address, Lucas claims that all modifications to his model from the literature taken together are not able to give a significant welfare improvement from the elimination of business cycles.

In recent years, there has been much progress in working with heterogeneous agent models with business cycles. And these models can highlight costs from business cycle fluctuations in the order of 1% of consumption. Their more important result is that this cost is very unequally distributed, which makes it very significant to some. Take two examples. Tom Krebs argues that the real cost of business cycles is in the long-term job displacement of workers. The reason is that short-term fluctuations can have long-term consequences. Or Per Krusell, Toshihiko Mukoyama, Ayşegül Şahin and Anthony Smith show that the elimination of business cycles not only smooths variables, but also changes their average level. The latter happens because of changes in precautionary savings and through the resulting changes in prices. Both papers also show that there are strong redistribute forces at work, and the welfare impact of aggregate fluctuations is worth several percents of consumption in some worker categories, something worth caring about.